Households hold key to more rate hikes

How consumers respond to the challenging mix of rising living costs and higher interest rates on one side and a strong labour market and increasing wages on the other will go a long way to determining how tight the Reserve Bank fo Australia turns the monetary policy screw.

In his statement announcing a 0.5 percentage point increase in the cash rate to 0.85 per cent, Reserve Bank Governor Philip Lowe made it clear that interest rates will rise further, saying, “The [RBA] Board expects to take further steps in the process of normalising monetary conditions in Australia over the months ahead”.

Mr Lowe says he expects inflation to ease next year back within the 2 to 3 per cent range which is the central bank’s target band. But this is predicated on more rate rises.

The only question is how high interest rates will need to go, and how fast.

Internationally, a lot will need to go right if rate rises are to be modest.

The extreme pressure on global supply chains of food and energy will need to ease and commodity prices stabilise. This will involve many countries currently affected by the supply shock caused by the Ukraine War being able to find alternative suppliers. It will also require food and energy exporters to be able to increase their production, something that climatic conditions and transport systems could impact on.

China’s response to COVID-19 also remains a key point of uncertainty. Though Shanghai is emerging from lockdown and restrictions in Beijing are not as tight for now, as long as China sticks with its Zero Covid policy more lockdowns are a real possibility.

Even if international conditions improve, how Australian households behave over the coming months will be crucial.

Though many households have built up savings and those with equity in the housing market have experienced a significant increase in asset wealth, how they respond to rising prices and interest rates will be telling.

The RBA’s central case is for strong consumption growth this year as many consumers, buoyed by strong savings, high house prcies, a tight jobs market and rising wages, feel comfortable enough to splurge.

If they do, it is likely to mean interest rates will have to go higher than they might otherwise.

But there are good reasons to think that many will act more cautiously. Renters, those on low incomes and those carrying big mortgages, in particular, may all feel good reason to keep a tight rein on spending.

As the Reserve Bank Board deliberates on further rate hikes over coming months, retail spending, household borrowing and credit card statistics will be among the key indicators it will be keeping a close eye on.

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